Apache masters the art of the deal

LisaSanders

HOUSTON (CBS.MW) - Apache seems to have the Midas touch when it comes to picking up property at a fair price, exploiting that property in terms of production and creating value for its shareholders.

Some might call it luck, but that would negate the thought and planning that's behind every Apache
APA, -2.87%
acquisition.

Investors have noticed. Apache ended 2000 near its high for the year and with a market capitalization close to $9 billion.

"Here is a company that does a few things very well," said Barry Borak, a managing director of a large-cap value fund at David L. Babson Co. "They have a knack for acquiring properties at the right time."

On Friday, for instance, Apache completed its $490 million acquisition of Phillips Petroleum's assets in Western Canada. Investors applauded the deal not only for Apache's ability to make an acquisition in high-priced commodity environment but also because the assets are expected to be immediately accretive to earnings and cash flow.

The property, in the Zama area of Northwest Alberta, has 71.6 million barrels of oil equivalent and reserves that are 59 percent weighted toward natural gas.

"You get an announcement like Zama in Alberta, and that gives Apache free cash flow...they can use for other projects," Borak said.

The fact that Apache is more heavily weighted toward natural gas, a commodity which has been soaring in price, is also an attraction. Apache is about 55 percent leveraged to natural gas.

"We have gone more toward natural gas stocks because there are issues with storage and demand seems to be growing," said Borak. "With the oilier names, you're dealing with OPEC, and there's a lot of politics and it's much more complicated in terms of reliability."

Babson took a position in Houston-based Apache, one of the five largest independent exploration and production companies, three years ago. When Apache came to market with a secondary offering in 1999, Babson added to its stake in the company.

Apache's thought process

Raymond Plank, Apache's 77-year-old chairman and chief executive officer, said the company predicted in the late 1990s that commodity prices would head lower.

"So we got our balance sheet stronger," Plank told CBS.MarketWatch.com. "That put us in a position - as other companies were selling off assets - to grow our company, believing it was better to buy low and sell our commodities in a more favorable market at a later time. By 1999, we were in a good position to make a major move."

Apache is active in two ways. The company does a lot of drilling; in 2000 it drilled more than 1,000 wells, both onshore and off. And it acquires properties, focusing in core areas where value can be added and costs can be reduced.

"We've become known around the industry as a reliable buyer, we analyze assets effectively and pay a fair price, and then we get on what is a niche strength - increasing the amount of oil and natural gas that would otherwise be recovered," Plank said. Hear discussion of strategy.

Shell Offshore was the first of a series of property acquisitions begun in 1999. From the end of the first quarter of 1999 to the end of the third quarter of 2000, Apache has increased production 60 percent. Production-per-share has grown 33 percent.

Also during that period, the company's debt-to-capitalization ratio has decreased from 46 percent to 36 percent; cash from operations has risen to $452 million from $84 million, a 438 percent jump; and its equity has increased by 95 percent to $3.5 billion from $1.8 billion.

What's more, Apache posted a loss of 4 cents a share in the first quarter of 1999; in the third quarter, the company's profit on a diluted basis was $1.61 a share, 7 percent better than analysts polled by First Call had expected.

"These are opportunity focused, smart folks," said Mark Fischer, an oil and gas analyst for Banc of America Securities. "All of their acquisitions have been accretive, and they've done a surprisingly good job in a difficult environment."

Plank does not rule out an acquisition that isn't immediately accretive if there is long-term upside.

New opportunities

"It's not a requirement to the purchase, but we've been fortunate that what has attracted our interest has been accretive," Plank said. "Our purpose is to keep our cash flow as high as the then-existing prices will allow us and expand over a period of time from core areas.

Although most of Apache's holdings are in the U.S. and Canada, it also has property in Australia, China, Poland and Egypt.

"The most significant area right now is Egypt," Plank said. "We entered there in the early 1990s, and we got lucky on our second well with a producer of 11,000 barrels a day. It was assumed that the field and others would produce 35 million barrels. We're now on our way to 100 million barrels."

"Gas is the preferred commodity," Plank said. "But we're fishing all the time, and have several lines over the side of the boat."

Tom Driscoll, an analyst covering Apache for Lehman Bros., upgraded the stock to "buy" from "outperform" on Nov. 14. He said that the challenge for Apache is addressing the issue of the decline curve, since oil and gas are depleting assets.

"How do you offset production declines," Driscoll said. "That has the potential to be a tough challenge for them."

Plank notes that Apache has a great deal of production coming on line next year, and that production from international assets is a lengthier process than in North America.

"That's why we have a portfolio approach," Plank said. "Next year, we'll produce a couple of hundred million barrels. So, if our revenue is $3 billion, you've got to find what would replace $3 billion. Active drilling and acquisitions will keep growth going." Listen to interview.

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